Profitability ratios are calculated on the basis of profit earned by a business. This ratio gives a percentage measure to assess the financial viability, profitability and operational efficiency of the business. The various important Profitability Ratios are as follows:
Gross Profit Ratio: It shows the relationship between Gross Profit and Net Sales. It depicts the trading efficiency of a business. A higher Gross Profit Ratio implies a better position of a business, whereas a low Gross Profit Ratio implies an inefficient unfavourable sales policy.
Gross profit Ratio = \(\frac {\textit{Gross profit}}{\textit{Net Sales}} \)
Gross Profit = Net Sales – Cost of Goods Sold
Net sales = Total Sales – Sales Return
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses — Closing Stock
Operating Ratio: It shows the relationship between Cost of Operation and Net Sales. This ratio depicts the operational efficiency of a business. A low Operating Ratio implies higher operational efficiency of the business. A low Operating Ratio is considered better for the business as it enables the business to be left with a greater amount after covering its operation costs to pay for interests and dividends.
Operating Ratio = \(\frac {\textit{Operating Cost}}{\textit{Net Sales}} \times 100\)
Operating Cost = Cost of Goods Sold + Operating Expenses
Cost of Goods Sold = Sales – Gross Profit
Operating Profit Ratio: It shows the relationship between the Operating Profit and Net Sales. It helps in assessing the operational efficiency and the performance of the business.
Operating Profit Ratio = \(\frac {\textit{Operating Cost}}{\textit{Sales}} \times 100\)
Operating Profit Ratio = 100 – Operating Ratio
Operating Profit = Sales – Operation cost
Net Profit Ratio = \(\frac {\textit{Net Profit}}{\textit{Net Sale}} \times 100\)
or,\(\frac {\textit{Profit Before Tax}}{\textit{Net Sales}} \times 100\)
or,Net profit Ration = \(\frac {\textit{Profit After Tax}}{\textit{Net Sale}} \times 100\)
Net Sales = Total Sales – Sales Return
Return on Investment or Capital Employed: It shows the relationship between the profit earned and the capital employed to earn that profit. It is calculated as:
Return on Investment or Capital Employed = \(\frac {\textit{Profit before interest and Tax}}{\textit{Capital Emplyed}} \times 100\)
Capital Employed = Fixed Assets + Current Assets- Current Liabilities
Or,
Capital Employed = Share Capital + Reserve and Surplus + Long-term Funds-Fictitious Assets
Earning per Shares: It shows the relationship between the amount of profit available to distribute as dividend among the equity shareholders and number of equity shares
Earning per share = \(\frac {\textit{Profit available for equity share holders}}{\textit{Number of equity shares}} \)
Profit available for equity shareholers = Net Profit after tax
Dividend payout Ratio: It shows the relationship between the dividend per share and earnings per share. This ratio depicts the amount of earnings that is distributed in the form of dividend among the shareholders. A high Dividend Payout Ratio implies a better position and goodwill of the business for the shareholders.
Dividend payout ration = \(\frac {\textit{Dividend per share}}{\textit{Earning per share}} \)
Dividend per share = \(\frac {\textit{Dividend paid}}{\textit{No.of share}} \)
Price Earnings Ratio: It shows the relationship between the market price of a share and the earnings per share. This ratio is the most common tool that is used in the stock markets. This ratio depicts the degree of reliance and trust that the shareholders have on the business.
price Earning Ratio = \(\frac {\textit{Market Price of a share}}{\textit{Earnings per share}} \).
